Merrill Lynch On The ECB

by: John Jansen

Merrill's main criticism or concern on the ECB actions is the failure to indicate at that at some point the European central bank would do QE by purchasing sovereign debt. If the ECB had acted to drive those yields lower, then our bonds would have been a relative value sanctuary and a virtual high yielder. The Merrill analysts believe that is why the reaction to the array of other measures was so subdued.

I think the jury is out on that and the main reason for the muted response is that the labor report impends Friday. I believe consensus is 210K for Friday. If we print on consensus I think the mark will push lower in yield from current levels in a delayed response to the ECB.

Via Merrill Lynch:

  • ECB gets credit. The ECB exceeded market expectations by delivering not only rate cuts and a targeted LTRO, but also a second LTRO for existing assets. Additionally - and unexpected - the central bank is going to stop sterilizing its existing assets acquired under the 2010-2012 SMP program. Recall that back then the ECB purchased peripheral sovereign bonds - but stopped short of outright QE to avoid monetizing government debt. The way this works is that the ECB drains the money created from these sovereign debt purchases in weekly deposit operations. Effectively the ECB borrows from the public to fund their holdings of sovereign debt. Now by ending sterilization the ECB effectively does a "delayed QE". They first bought the assets in 2010-2012, and now years later they print the money to fund them.
  • That said, notably absent from today's ECB releases/press conference was any discussion of future QE involving sovereign debt. That is crucial for the outlook for US credit, as it limits the downward pressure on US interest rates that investors shorting Treasuries were so concerned about. Hence the minimal reaction despite the ECB doing more than expected, with 5 and 30-year interest rates 1.5bps lower and 0.3bps lower, respectively. However, most measures - including the discussion of potential future ABS based QE - are clearly positive for credit as investors are crowded out of yield opportunities. Obviously most directly positive for European credit, but also indirectly for US credit as relative value improves. Hence US investment grade and high yield tightened 1.7bps and 0.26pts (CDX), while European IG tightened as much as 3.8bps (iTraxx). It should not be long before Main trades inside IG, especially as with the ECB out of the way US interest rates can better reflect the strength of the US economy. - Hans Mikkelsen (Page 4)
  • ECB Review: carrots and sticks. The ECB failed to surprise and create a market rally and lift expectations for QE today, as they focused on their traditional monetary policy reaction function. In our view, the ECB delivered monetary policy loosening (with cuts to its rates, including the depo down to -10bp), mechanisms to stimulate bank lending and improve transmission mechanisms (targeted LTROs with a long maturity), hints to possible ABS purchases, but no free lunch. The TLTROs seem to be designed to avoid the sovereign carry trade -although we lack details to assess the extent of this. In addition, although the ECB clearly acknowledged risks to their already very low inflation projection, they carefully avoided to mention sovereign bond purchases as the obvious solution for another deterioration of the inflation outlook. - Laurence Boone, Ralf Preusser, CFA, Athanasios Vamvakidis (Page 11)

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